4 Years on Legal Weed Market Favors Big Businesses

As California opens its market, Washington’s experience serves as a warning. This post from FiveThirtyEight.com explains why legal weed market is tough on small businesses.

The business of selling legal weed is big and getting bigger. North Americans spent $6.7 billion on legal cannabis last year, and some analysts think that with California set to open recreational dispensaries on Jan. 1 and Massachusetts and Canada soon to follow, the market could expand to more than $20.2 billion by 2021. So it’s no surprise that you see eager business people across the country lining up to investmillions of dollars in this green rush.

But here’s a word of warning for those looking to dive head-first into these brand-new legal weed markets: The data behind the first four years of legal pot sales, with drops in retail prices and an increase in well-funded cannabis growing operations, shows a market that increasingly favors big businesses with deep pockets. As legal weed keeps expanding, pot prices are likely to continue to decline, making the odds of running a profitable small pot farm even longer.

Washington offers a cautionary tale for would-be pot producers. The state’s marijuana market, for which detailed information is available to the public, has faced consistent declines in prices, production consolidated in larger farms and a competitive marketplace that has forced cannabis processors to shell out for sophisticatedtechnology to create brand new ways to get high.

“A lot of people (in Washington) are surprised, and a lot of people are in denial about the price dropping,” said Steven Davenport, a researcher with the RAND Corporation. “The average price per gram in Washington is about $8, and it’s not clear where the floor is going to be.”

Davenport has watched the legal weed market from its inception, starting with his work as a consultant to regulators in Washington state in 2013 when they were writing the rules that would govern the country’s second legal weed market,1 which allowed for both growing pot and licensing businesses to sell the product the following year.

There wasn’t a lot of data on how the market for cannabis worked back in 2013, and the regulators in Colorado and Washington were trying to write rules for a product that had never been sold on any regulated market. Questions about the market dynamics behind selling pot were in some ways unanswerable, the telltale information buried deep in the ledgers of black market dealers.

Now, four years later, as entrepreneurs launch recreational cannabis businesses in California and Massachusetts, the tables have turned. With legal pot sales happening every day in five states, there’s a wealth of data about how the market works. In fact, there might be more public data on how this market works than any other market in the world thanks to a public database2 containing each legal weed transaction that has taken place in Washington state. The massive, 45-gigabyte database tracks every plant as it is harvested, processed and sold.3

This data shows that legalization has been extremely disruptive to the previous ways of growing and processing pot, when small, underground weed businesses could stay afloat with a basement full of grow lights.

“Prices are declining, the industry is consolidating, product variety is exploding — and none of that is a surprise,” said Jonathan Caulkins, a professor at Carnegie Mellon University and a former co-director of RAND’s Drug Policy Research Center who co-authored a book in 2012 called “Marijuana Legalization: What Everyone Needs to Know.” “Those are all things that we predicted well in advance because they are natural consequences of legalizing along a for-profit commercial model.”

Declining Pot Prices

Pot shoppers didn’t have much of an economic incentive to purchase legal weed when Washington’s first recreational stores opened in July 2014. With only a handful of farms and stores licensed to sell legal pot, the market’s supply was constricted, and the average retail price per legal gram in that first month of sales was $32.48,4considerably higher than the black market or medical market prices.

The average retail price went up to $35.67 the following month, according to the state’s data as provided by TopShelfData.com, but pot prices have seen a steady decline since then: Within six months, the average retail price had dropped to $21.07 a gram; a year later, after a change in state taxes,5 pot was averaging just $12.32 a gram; and by September of this year, the average retail price for a gram was $7.45, or 77 percent cheaper than when the legal market first began. Producers in September were getting an average wholesale price of $2.53 a gram of pot.

Those prices are a lot lower than what the pot farmers thought they would be getting for a wholesale gram when they were first applying for licenses at the end of 2013, according to Susan Gress, a legal pot farmer on Vashon Island, just outside of Seattle.

“It was just blue sky estimates, anything from $5 to $25 — nobody had any idea. We were hoping for somewhere around seven or eight (dollars a gram), and back in those days, we were able to get $8 a gram,” Gress said. “But things have changed.”

Gress, who used her retirement savings to start the Vashon Velvet pot farm in an old horse barn on her property, said she thinks her brand has a better chance of surviving because it is considered premium and she is able to charge closer to $5 for a wholesale gram. But not everyone will manage to keep going as prices go down.

It’s fairly obvious why growing has gotten cheaper, Caulkins noted: On the one hand, pot farmers no longer have to spend time and energy avoiding police; on the other, industrial farming techniques and engineers are now involved in the industry, designing state-of-the-art grow facilities to increase efficiency and lower production costs. These changes — with their related price drops — are only likely to continue.

California and Massachusetts are starting their own legal markets in 2018, and prices will decline even further if the federal government ends its prohibition, according to Caulkins.

“Once it’s nationally legalized and farmers can grow it just like tomatoes and asparagus, it will be crazy cheap to grow compared to what it was in the past, and it will be either crazy cheap or pretty darn cheap to process, depending on which kind of product you are making,” Caulkins said.

Consolidating Cannabis Farming

When Washington’s regulators set up their market for legal cannabis, they created three tiers of pot producers based on the square footage of each farm. License different sizes of farms, the thinking went, and the market will support a range of small, medium and large producers.

Fast-forward three years, and it appears this thinking was flawed. Big recreational producers have swallowed up most of the market, pushing out the small-scale growers of the black and medical markets. From January through September of this year, the 10 largest farms in Washington harvested 16.79 percent6 of all the dry weight weed grown in the state, which is more than the share produced by the 500 smallest farms combined (13.12 percent).

Davenport said this consolidation of cannabis farming in Washington is just a harbinger of what’s to come. “I think what has become more clear is the inevitability of pretty large-scale production, and that is really going to start to drive down production costs,” Davenport said.

Current regulations keep pot farms from infinitely expanding, but as legalization marches forward, bigger farms could well be permitted. This summer, regulators in Washington expanded the maximum farm size from 30,000 square feet to 90,000. California plans on capping farms at 1 acre, or 43,560 square feet, when the market first launches. But the state rules do not currently stop farmers from using multiple licenses, which opens the door for larger farms.

What would happen if pot farms could be as large as wheat or corn fields? According to Caulkins, 10 reasonably sized farms could conceivably produce the entire country’s supply of tetrahydrocannabinol, pot’s most famous active chemical (usually shortened to THC).

“You can grow all of the THC consumed in the entire country on less than 10,000 acres,” Caulkins said. “A common size for a Midwest farm is 1,000 acres.”

The economic pressure on small pot farmers is only likely to increase if a nationwide market for cannabis opens up and the country’s largest, multibillion-dollar agriculture companies are able to invest in production — something they are blocked from doing7 until the federal government changes its laws.

“The professionalization of the industry is an ongoing thing,” Caulkins said. “There has been enormous change, but there is at least as much change still to come.”

It’s Not Your Parent’s Pot

Walk into a legal weed store, and you’ll see shelves of products that hardly resemble the pot of Cheech & Chong. From weed mineral waters to pot topical rubs to cannabis sodas, producers use sophisticated and expensive equipment to get creative with how they deliver pot to their customers. And Washington’s weed data shows that consumers have clearly developed a taste for these processed products.

When legal weed stores first opened in Washington in July 2014, flower — the unprocessed nuggets of cannabis that can be put into pipes or joints — made up 94.80 percent of the market, but a year later, flower accounted for only 72.62 percent of sales. That share had further dropped to 54.50 percent by September of this year, the date of the most recent available data from TopShelfData.com.

Other forms of pot — like concentrates, vapes and edibles — take up the rest of the market. Concentrates, highly potent products that can be consumed in a variety of ways, made up just 5.2 percent of all sales in July 2014 but accounted for 17.96 percent in September of this year. Vape cartridges, which allow cannabis to be consumed through electronic cigarettes, accounted for 7.67 percent in September, while edibles made up 8.46 percent of sales.

Caulkins said this kind of diversification is only natural in an industry where the basic product — loose-leaf flower — is relatively cheap to produce. “If you take the same amount of marijuana and put it into an edible, then your edible might taste different than a competitor’s and so be differentiated by its other ingredients,” Caulkins said. “They are trying everything they can to differentiate their product so they can command a price premium.”

While it’s relatively cheap to grow and sell unprocessed pot, it can take a massive investment in equipment to produce the edibles and concentrates that are becoming increasingly popular. Products like flavorless pot mineral water or concentrates so pure they form crystals are made with a combination of pharmaceutical and food science technology and cost hundreds of thousands of dollars in equipment to produce. For small-business owners, it can be difficult, or impossible, to buy the equipment it takes to produce modern pot edibles themselves.

This business climate appears to limit the number of companies willing to produce edibles. Of the more than 1,000 Washington companies with active licenses that would allow them to process edibles in the 12 months prior to September 2017, only 74 companies sold an edible, according to TopShelfData.com. And, just like with flower, a few large companies dominated the edible market. The five largest edible producers were responsible for 51.15 percent of the $38.7 million in edibles sold during those 12 months. The top 20 edible producers accounted for 90.48 percent of edibles during that time period.

As legal weed expands across the continent, that drive to find a way to charge a premium for pot won’t end anytime soon. Combined with dropping pot prices and consolidating production, it isn’t likely to get any easier for small-business owners to find a profitable way to sell legal weed.